Monday, June 27, 2011

IEA targets Oil Bubble

THE International Energy Agency (IEA) has been saying since the turn of the year that oil prices were too high for the world economy. Today it acted to crash the market.

Announcing the release of 60 million barrels of crude oil – or 2 million barrels a day for the next 30 days – the IEA said it was replacing output lost during Libya’s conflict. The war there has starved the market of quality oil and supported Brent prices. The IEA claimed 132 million barrels have been lost since the start of May.That means this stock release may not be the last. The IEA’s statement was explicit: it will review the market within 30 days and decide on further action. A 4.1 billion barrel war chest gives it ample oil to douse the market. If that doesn’t send bulls running for cover, the involvement of Saudi Arabia should.The stock release immediately put the skids under oil prices. Brent fell to below $106 a barrel, before staging what will surely be a short-lived recovery to around $108/b.

Crude Future

But forget Libya. The IEA is manipulating the market lower. Libya’s outage gives cover to a political decision to burst an oil bubble that the agency believes has pushed Western economies into the red zone.

Consumer/producer collusion

The most plausible theory now doing the rounds is that a tacit agreement between the IEA, the US and Saudi Arabia went along the following lines: whatever happened at the Opec meeting on 8 June, the kingdom would make oil available to the market. If that didn’t soften prices – and it didn’t – the IEA would release stocks.Saudi Arabia, said one analyst with close knowledge of its oil policy, has at last become convinced the US economy is in serious danger and that a strategic weakening of the oil market is necessary.

OECD Crude Product Stock

Meanwhile, the US has spent recent weeks signalling that it may unilaterally release its own stocks. A combined release by IEA members is a much more powerful signal to the market – and one for which the White House has lobbied hard.

With the three most powerful forces in the global oil market – its biggest consumer, its biggest exporter and its biggest bank of stocks – colluding to drive prices lower, support for oil prices cannot last.

Black day for the bulls

And there could be more black days for the oil market’s bulls, as the spectre of 2008 begins to hover over global markets. The global economy looks weaker by the day. New US jobless figures released on 23 June were worse than expected. Data from China showed that its manufacturing sector has now stalled – the consequence of the government’s efforts to dampen inflation.

The Eurozone is facing a sovereign-debt crisis that shows little sign of easing – and, if Greece defaults, could grow much worse when the wolf pack moves onto southern Europe’s other troubled economies.

The West is running out of options to revive its dying patient. Rock-bottom interest rates haven’t worked. Drastic debt-reduction plans have hurt growth in some economies. A competitive devaluation of the dollar hasn’t solved the unemployment problem in the world’s most important economy.

Federal Reserve boss Ben Bernanke reckons US GDP will grow by as little 2.7% this year, compared with earlier estimates of up to 3.3%. And extending the quantitative easing programme beyond the end of the month is out of the question – inflation is too great a worry.

Releasing crude from strategic stocks is drastic shock therapy, and it comes after the other treatments have failed.The price correction has already started. Now the IEA has to hope it lasts. It should, because if it doesn’t, the outlook, especially in Western economies, is bleak. Either way, the coming months will be bumpy.

How many times has the IEA undertaken such a “collective action”? When was the last time?
On a global scale, this is the third time IEA member-country stocks have been used. IEA member countries released oil stocks in 2005, after Hurricane Katrina damaged offshore oil rigs, pipelines and oil and gas refineries in the Gulf of Mexico. The only other occasion IEA member countries mandated a stock release was at the time of Iraq’s invasion of Kuwait in 1990/1991.

How much time will it take for these stocks to become available?
Oil supplies from IEA member countries should begin hitting the market around the end of next week.

How much oil will each country release? Will each country release the same proportional amount, or will some countries do more? How is that decision made?
Country shares are based on their proportionate share of total IEA oil consumption – so larger oil-consuming countries obviously have a bigger share in the overall release. In this case, all IEA countries holding strategic stocks and representing more than 1% of IEA final oil consumption are participating. It is expected that North America will release 50 percent of the total, with European countries releasing some 30 percent and Asian countries providing the remaining 20 percent.The IEA will produce a tally once it has a clear indication of the types of oil that each country will make available.

Has the IEA consulted with OPEC or Saudi Arabia on this decision? Would this IEA action not discourage Saudi Arabia and other willing OPEC members from increasing oil production?

The IEA and its member countries have been in close contact with key oil producing countries, and in particularly with Saudi Arabia, which holds the lion’s share of OPEC’s spare capacity. The IEA welcomes the announcement made by Saudi Arabia that it intends to make incremental oil available to the market. However it will take time for these incremental barrels to be produced and shipped to consuming markets; the use of IEA strategic stocks now will help bridge the gap until these new supplies are available.
Producers and consumers have a common interest in stabilising oil markets. This point has been highlighted many times before, and is a reason for the IEA’s close liaison with key oil producing countries at all times.

I thought the IEA only does this for supply disruptions in excess of 7%. The 1.5 million-barrels-a-day disruption from Libya doesn’t seem all that much, given that global demand is around 88 mb/d, so why go to all the trouble?

As far back as 1984, IEA member countries understood that a disruption of a much smaller scale than 7% could cause significant economic damage, and thus they adopted more flexible response measures. The two previous emergency IEA actions, in 1991 and 2005, each accounted for less than 7% of world demand. Particularly in a tightening market such as the one we see currently, a relatively small disruption can have a significant impact on the market.

If the disruption from Libya is 1.5 million barrels per day, why are the IEA member countries releasing 2 million barrels per day?

By the end of May the Libyan crisis had removed 132 million barrels of crude from the market. Commercial stocks in the OECD countries have tightened as a result. Because crude demand peaks during the summer season in the Northern Hemisphere, we estimate that preventing further market tightening in the third quarter will require 2 million barrels per day of additional supply. Our action aims to provide market liquidity until incremental production comes to the market.

Libyan supplies have been off the market since February. Why are you only doing this now?

The IEA is prepared to act when there is a significant supply disruption or an imminent threat thereof. Since the Libyan crisis began, the market has focused on the potential for further tightening in both OECD industry stocks and OPEC spare capacity. The onset of the Libyan crisis fortuitously coincided with the peak of the European refinery outages, primarily linked to seasonal maintenance work, and thus lower demand for crude oil. Now, heading into the “driving season” in the Northern Hemisphere, demand for crude will rise as refiners seek to replenish product stocks ahead of rising transport fuel demand. This seasonal increase in demand, combined with OPEC’s announcement at their 8 June meeting not to increase production to fill the gap with the necessary additional supplies, represents an imminent risk, which is why the IEA has chosen to take decisive action now.

Are IEA countries not putting at risk their capacity to react to more serious oil disruptions that may happen in the coming months considering geopolitical uncertainties in MENA countries?

No; IEA countries benefit from a very large safety net with their stocks: Total IEA stocks amount to more than 4 billion barrels, of which 1.6 billion are public stocks held exclusively for emergency purposes. This is equivalent to 146 days of net imports. So even after this 60-million-barrel collective action, all participating countries’ stocks will remain above 90 days of their net oil imports.